Saturday, October 17, 2009

Pensions in a Neo-Feudal World?

About the Author

Dan Denning is the author of 2005's best-selling The Bull Hunter (John Wiley & Sons). Dan draws on his network of global contacts from his base in Melbourne. He’s the managing editor of resource newsletter Diggers and Drillers and the editor of The Daily Reckoning Australia.

Regrettably, your editor was back at the doctor's office early this morning being diagnosed with tonsillitis after a lousy night. We were especially disappointed because scheduled for today was a noon lunch with Dr. Michael Hudson. His tour of the country is being sponsored by Prosper Australia and tonight at the Melbourne Town Hall at 6:30 Dr. Hudson and Dr. Steve Keen will be "lifting the lid on the GFC."

We're not sure if there are still places available. It's free, but you'll have to RSVP. You can do so here. It's a great chance to hear two independent thinkers offer an alternative explanation for what's going on, an alternative to the rosy everything's fine clap trap in the mainstream.

If you're not in Melbourne or can't make it, don't worry. We're going to take up some of Dr. Hudson's main contentions over the next month and "unpack them" as the saying goes. Among other things, he's arguing that we are moving to a "Neo-Feudal" world where the landlords and the bankers are again in charge of the economy (and the world).

Their strategy is to get the rest of the country into as much debt as possible. Whether this is so they can increase their claims on financial wealth (rents, interest payments, and capital gains on asset prices) or whether it's a political program to subjugate the population...that's one of the questions we were going to ask.

We were also going to ask if the "de-industrialisation" of advanced Western economies that Dr. Hudson talks about is a reversible process. Can Europe and America ever compete with China and Asia in manufactured goods? And if they can only do so in high-end goods (capital goods, technology, aerospace, IT etc.) what does that mean for the structure of employment in Western economies and corporate earnings.

Dr. Hudson, it seems to us, is right to point out that there is a kind of "Financial Oligarchy" that seems to be benefiting the most from the financialization of the economy. But everyone else - those betting on higher share and house prices to pay for retirement (and pay off huge debts) - may not fare so well. What should you do? What can you do? More on this in future reckonings.

Michael Hudson was also on Max Keiser on Friday discussing his views on how Latvia is getting screwed by the IMF, the EU, Swedish and German banks (watch YouTube video below or click on link above):

Michael Hudson's views have been critically reviewed, most recently by Vjačeslavs Dombrovskis who wrote this on "Stockholm Syndrome":

Meet Michael Hudson, a "well known economist and Professor at University of Missouri" (yesterday's Delfi). The "well-known" part is not, strictly speaking, true - not among the economics profession, at least. Further, although Mr. Hudson has a PhD in economics (NYU), during his (long) professional life he hardly published anything in the economics mainstream. However, I think Mr. Hudson is to be watched. He is an interesting person. Also a rather dangerous one.

What makes him interesting is his other affiliation - being a leading Member of Reform Task Force Latvia (RTFL), "initiated by the Harmony Center (Saskanas Centrs) political alliance" [emphasis mine]. Need I remind you that Harmony Center has a very strong lead in every polls and national election is merely a year away? This task force "brings together people whose ideas … are ahead of our time". There is no shortage of ambition. "We wish a new order" - so says the mission statement [emphasis their].

What makes Mr. Hudson dangerous is a mix of some very sensible ideas with populism and extremism. His "Latvia's Stockholm Syndrome", which likens IMF and EU program to "a declaration of economic war against Latvian labor and industry" isexactly the kind of stuff that media love. The 'Syndrome' paper is a set of poorly structured, rambling attacks on the IMF, EU, neo-liberal economists, banking special interests, etc. It's sheer venom, near absence of coherent argument, and overabundance of flashy metaphors would be appalling to any serious economist. But I suspect it's all exciting stuff to people on the streets.

Lets start with his sensible points. There are two. First, he correctly questions the banks' role in Latvia's economic ordeal. It’s probably true that 'too much has been lent', so that the sum of banks' outstanding claims is (significantly) smaller then the market value of all real estate collateral plus whatever residual claims can be recovered from individual (and corporate) borrowers. Somebody has to incur those losses.

There are some very legitimate questions as to whether the present "keep-the-peg" program is not a way to spread the banking sector's losses over Latvia's population at large. If you add State Control (Valsts Kontrole's) report basically saying that Latvian taxpayers fully bailed out Mr Kargins and Mr Krasovickis (of Parex), there are good chances that an increasing number of people would sympathize with this kind of thinking. Mr. Hudson's second sensible point concerns his frequently recurring argument that Latvian tax system is severely biased towards taxing labor and extremely benign in taxing land. Well, I have been talking about this (not the land tax though) for better part of the last five years.

What does Mr. Hudson want? There are lots of slogans that Latvia should "stay away from IMF central planners like the plague", and become "economically independent". I see two practical proposals in the 'Syndrome' piece. The first one is, actually, quite a good one - to introduce a land value tax so as to reduce the tax burden on labor (e.g. personal income tax).

Land tax minimizes something that is called "excess burden" of taxes (i.e. distortions) because land supply is perfectly inelastic. William Vickrey (a 1996 Nobel prize winner in economics), for example, advocated replacing nearly all taxes with land value tax to improve economic efficiency. The second suggestion is more 'fun': "Latvia needs to act as a sovereign nation and denominate its debt in its own currency." I presume Michael Hudson means private sector debt, but I wonder whether it also applies to the IMF/EU loan. This is equivalent to a default, of course. My interpretation of Mr. Hudson's justification for this is that unknowing victims of global conspiracy by financial interests need not honor their obligations.

This brings me to what my problem with this is. I, personally, have no illusions that Mr. Hudson is, to put it bluntly, more than a little Marxist. A central theme of his "Syndrome" piece (and other work) is workers being ruthlessly exploited by capitalists with the aid of IMF, World Bank, and their loyal servants - neo-liberal economists. RTFL is trying to position itself as a liberal (U.S. sense) 'New Deal' force (read the "mission"), but have no illusions about it- it is Marxist through and through, rooted in the class-struggle view of the world. The 'Syndrome' is riddled with things like " "free-market Bolshevism", "neo-liberal junk economics", "destructive neo-liberal Lisbon program",and generally equating "business friendly" with "anti-labor".

All in all, however, I think it's good that Michael Hudson is busy developing, as it seems to me, economic ideology of the Saskanas Centrs. Finally, a more serious fight for people's "hearts and minds" is about to begin.The message developed by Mr. Hudson is simple and attractive to the masses - as Bolsheviks' ideas, no doubt, were in 1917. I am afraid there would always be a thriving market for ideas like "it's not your fault you're poor, it's because of a global conspiracy of the rich and powerful". Finally, no matter how fundamentally flawed his ideas are, I am sure Mr. Hudson will be more than a match for Latvia's lethargic intellectual 'mainstream'.

Now, let me stop right here to tell you that Michael Hudson is part of an email distribution list I receive called UglyNewWorld. Mr. Dombrovskis' comments are erroneous and totally biased. He is neither "dangerous" nor is he a "Marxist" but a vehement critic of the bailout to U.S. banks, which last year he correctly pegged as multi-trillion dollar bailout, not an $850 billion bailout. Listen to the interview below done last year and read Michael's article posted on his website, Financial Bailout: America's own Kleptocracy.

Seth Merrin, the outspoken head of block-trading platform Liquidnet, shook up a trading industry conference -- and conjured up the U.S. Revolutionary War -- on Friday when he said high-frequency traders harm traditional market players.

Merrin, whose private market caters mostly to buyside institutions, told an audience here that the world's fastest traders fail to provide liquidity in a broad array of stocks, and when they do, the resulting smaller bid-ask spreads end up costing institutions that trade larger blocks of stock.

"The institutions are the British Army in the Revolutionary War walking down the field in lock-step, proud and in red -- you couldn't get a brighter color. The high-frequency shops are the Americans hiding in the woods in their camouflage, picking them off one by one," Merrin said.

"We all know who won the war ... we kicked their asses," he told a Security Traders Association conference, to laughter.

High-frequency trading -- where banks, hedge funds and independent proprietary shops use lightning-quick algorithms to make markets and earn thin profits from inefficiencies in the myriad marketplaces -- has come under fire this year after politicians and others raised concerns about unfair markets.

The U.S. Securities and Exchange Commission is looking into the practice, which is estimated to account for more than half of overall U.S. equity volume, and is spreading quickly into other regions and asset classes.

Speaker after speaker over two days at the STA conference had defended high-frequency trading, arguing it reduces costs, curbs market volatility, and adds liquidity so that traders can move stocks even in a crisis such as last year's sell-off. The ultra-fast practice is generally seen by the industry as the natural evolution of increasingly electronic markets.

Merrin, whose market has relatively little high-frequency flow, said the practice has a "virtually unlimited capacity" to grow because every institutional buy or sell order creates a supply-demand imbalance from which the traders can profit.

"For every buyside algorithm that is created out there today -- whose sole purpose is take this large order, slice it into tiny pieces to mask it going into the market -- there are now thousands of computers on the other side that are sniffing that out," he said. "And those computers are ... more sophisticated than whatever algorithm you guys are applying."

This type of trading does not represent true market making, Merrin said, because it focuses primarily on the most liquid, large-cap stocks, such as Citigroup Inc (C.N), American International Group (AIG.N), and Bank of America (BAC.N) -- and far less on others.

"Yes, they're reducing the spreads, but it costs the institutions" because they're beating the institutions to the profits to be made on market imbalances, he said, adding he does not want to see this type of trading banned.

Rebuttal was quick.

Jamil Nazarali, managing director of electronic trading at a unit of Knight Capital (NITE.O), later told the conference the facts aren't there to back Merrin's claims.

Joseph Rizzello, CEO of the small National Stock Exchange, said high-frequency traders played a key role in smoothing out the crisis a year ago, adding that banning the practice would halve trading volumes.

On Thursday, Dave Franasiak, principal at law firm Williams & Jensen PLLC, who represents the STA in Washington, said Senators Charles Schumer and Ted Kaufman and other lawmakers raising concerns over high-frequency trading have encouraged "a sense of perceived inequality, where somehow the little guys are getting hurt."

Kaufman wrote in the Financial Times newspaper on Friday that, left unchecked, "high frequency trading could develop into a systemic risk, becoming simply too big and too fast to regulate." The SEC, playing a big part in the Obama administration's financial reform plan, aims to issue a concept release on high-frequency trading by year end.

Merrin, who admitted there was yet little data to back his claims, stressed that institutions need to become more familiar with the fast traders interacting with their orders.

"If the British didn't change their fighting stance, their tactic, and they didn't choose a different battlefield, they would have lost every war since then," he said.

The sad part in all of this is that pension contributions are funding this Casino Capitalism. Money is going to develop new ways to screw buyside clients that invest trillions in the markets. Pensioners don't stand a chance in a neo-Feudal world. I think it's time for a revolution, hopefully one without bloodshed, that will democratize the financial system by loosening the grip of the financial oligarchs.

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I am an independent senior economist and pension and investment analyst with years of experience working on the buy and sell-side. I have researched and invested in traditional and alternative asset classes at two of the largest public pension funds in Canada, the Caisse de dépôt et placement du Québec (Caisse) and the Public Sector Pension Investment Board (PSP Investments). I've also consulted the Treasury Board Secretariat of Canada on the governance of the Federal Public Service Pension Plan (2007) and been invited to speak at the Standing Committee on Finance (2009) and the Senate Standing Committee on Banking, Commerce and Trade (2010) to discuss Canada's pension system. You can follow my blog posts on your Bloomberg terminal and track me on Twitter (@PensionPulse) where I post many links to pension and investment articles as well as my market thoughts and other articles of interest.

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